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Congress passes fiscal cliff act

Pulling back from the “fiscal cliff” at the 13th hour, Congress on
Tuesday preserved most of the George W. Bush-era tax cuts and extended
many other lapsed tax provisions.

Shortly before 2 a.m. Tuesday, the Senate passed a bill that had
been heralded and, in some quarters, groused about throughout the
preceding day. By a vote of 89 to 8, the chamber approved the American
Taxpayer Relief Act, H.R. 8, which embodied an agreement that
had been hammered out on Sunday and Monday between Vice President Joe
Biden and Senate Minority Leader Sen. Mitch McConnell, R-Ky. The House
of Representatives approved the bill by a vote of 257–167 late on
Tuesday evening, after plans to amend the bill to include spending
cuts were abandoned. The bill now goes to President Barack Obama for
his signature.

“The AICPA is pleased that Congress has reached an agreement,” said
Edward Karl, vice president–Tax for the AICPA. “The uncertainty of the
tax law has unnecessarily impeded the long-term tax and cash flow
planning for businesses and prevented taxpayers from making informed
decisions. The agreement should also allow the IRS and commercial
software vendors to revise or issue new tax forms and update software,
and allow tax season to begin with minimal delay.”

With some modifications targeting the wealthiest Americans with
higher taxes, the act permanently extends provisions of the Economic
Growth and Tax Relief Reconciliation Act of 2001, P.L. 107-16
(EGTRRA), and Jobs and Growth Tax Relief Reconciliation Act of 2003,
P.L. 108-27 (JGTRRA). It also permanently takes care of Congress’s
perennial job of “patching” the alternative minimum tax (AMT). It
temporarily extends many other tax provisions that had lapsed at
midnight on Dec. 31 and others that had expired a year earlier.

The act’s nontax features include one-year extensions of emergency
unemployment insurance and agricultural programs and yet another “doc
fix” postponement of automatic cuts in Medicare payments to
physicians. In addition, it delays until March a broad range of
automatic federal spending cuts known as sequestration that otherwise
would have begun this month.

Among the tax items not addressed by the act was the temporary lower
4.2% rate for employees’ portion of the Social Security payroll tax,
which was not extended and has reverted to 6.2%.

Here are the act’s main tax features:

Individual tax rates

All the individual marginal tax rates under EGTRRA and JGTRRA are
retained (10%, 15%, 25%, 28%, 33%, and 35%). A new top rate of 39.6%
is imposed on taxable income over $400,000 for single filers, $425,000
for head-of-household filers, and $450,000 for married taxpayers
filing jointly ($225,000 for each married spouse filing separately).

Phaseout of itemized deductions and personal exemptions

The personal exemptions and itemized deductions phaseout is
reinstated at a higher threshold of $250,000 for single taxpayers,
$275,000 for heads of household, and $300,000 for married taxpayers
filing jointly.

Capital gains and dividends

A 20% rate applies to capital gains and dividends for individuals
above the top income tax bracket threshold; the 15% rate is retained
for taxpayers in the middle brackets. The zero rate is retained for
taxpayers in the 10% and 15% brackets.

Alternative minimum tax

The exemption amount for the AMT on individuals is permanently
indexed for inflation. For 2012, the exemption amounts are $78,750 for
married taxpayers filing jointly and $50,600 for single filers. Relief
from AMT for nonrefundable credits is retained.

Estate and gift tax

The estate and gift tax exclusion amount is retained at $5 million
indexed for inflation ($5.12 million in 2012), but the top tax rate
increases from 35% to 40% effective Jan. 1, 2013. The estate tax
“portability” election, under which, if an election is made, the
surviving spouse’s exemption amount is increased by the deceased
spouse’s unused exemption amount, was made permanent by the act.

Permanent extensions

Various temporary tax provisions enacted as part of EGTRRA were made
permanent. These include:

The American opportunity tax credit for qualified tuition and other
expenses of higher education was extended through 2017. Other credits
and items from the American Recovery and Reinvestment Act of 2009,
P.L. 111-5, that were extended for the same five-year period include
enhanced provisions of the child tax credit under Sec. 24(d) and the
earned income tax credit under Sec. 32(b). In addition, the bill
permanently extends a rule excluding from taxable income refunds from
certain federal and federally assisted programs (Sec. 6409).

Individual provisions expired at the end of 2011

The act also extended through 2013 a number of temporary individual
tax provisions, most of which expired at the end of 2011:

Deduction for certain expenses of elementary and secondary
school teachers (Sec. 62);

Exclusion from gross income of discharge of qualified principal
residence indebtedness (Sec. 108);

Parity for exclusion from income for employer-provided mass
transit and parking benefits (Sec. 132(f));

The act also extended many business tax credits and other
provisions. Notably, it extended through 2013 and modified the Sec. 41
credit for increasing research and development activities, which
expired at the end of 2011. The credit is modified to allow partial
inclusion in qualified research expenses and gross receipts those of
an acquired trade or business or major portion of one. The increased
expensing amounts under Sec. 179 are extended through 2013. The
availability of an additional 50% first-year bonus depreciation (Sec.
168(k)) was also extended for one year by the act. It now generally
applies to property placed in service before Jan. 1, 2014 (Jan. 1,
2015, for certain property with longer production periods).

Other business provisions extended through 2013, and in some cases
modified, are:

The IRS’s authority under Sec. 1445(e)(1) to apply a withholding tax
to gains on the disposition of U.S. real property interests by
partnerships, trusts, or estates that are passed through to partners
or beneficiaries that are foreign persons is made permanent, and the
amount is increased to 20%.

New taxes

In addition to the various provisions discussed above, some new
taxes also took effect Jan. 1 as a result of 2010’s health care reform
legislation.

Additional hospital insurance tax on high-income
taxpayers. The employee portion of the hospital
insurance tax part of FICA, normally 1.45% of covered wages, is
increased by 0.9% on wages that exceed a threshold amount. The
additional tax is imposed on the combined wages of both the taxpayer
and the taxpayer’s spouse, in the case of a joint return. The
threshold amount is $250,000 in the case of a joint return or
surviving spouse, $125,000 in the case of a married individual filing
a separate return, and $200,000 in any other case.

For self-employed taxpayers, the same additional hospital insurance
tax applies to the hospital insurance portion of SECA tax on
self-employment income in excess of the threshold amount.

Medicare tax on investment income. Starting Jan.
1, Sec. 1411 imposes a tax on individuals equal to 3.8% of the lesser
of the individual’s net investment income for the year or the amount
the individual’s modified adjusted gross income (AGI) exceeds a
threshold amount. For estates and trusts, the tax equals 3.8% of the
lesser of undistributed net investment income or AGI over the dollar
amount at which the highest trust and estate tax bracket begins.

For married individuals filing a joint return and surviving spouses,
the threshold amount is $250,000; for married taxpayers filing
separately, it is $125,000; and for other individuals it is $200,000.

Net investment income means investment income reduced by deductions
properly allocable to that income. Investment income includes income
from interest, dividends, annuities, royalties, and rents, and net
gain from disposition of property, other than such income derived in
the ordinary course of a trade or business. However, income from a
trade or business that is a passive activity and from a trade or
business of trading in financial instruments or commodities is
included in investment income.

Medical care itemized deduction threshold. The
threshold for the itemized deduction for unreimbursed medical expenses
has increased from 7.5% of AGI to 10% of AGI for regular income tax
purposes. This is effective for all individuals, except, in the years
2013–2016, if either the taxpayer or the taxpayer’s spouse has turned
65 before the end of the tax year, the increased threshold does not
apply and the threshold remains at 7.5% of AGI.

Health flexible spending arrangement. Effective
for cafeteria plan years beginning after Dec. 31, 2012, the maximum
amount of salary reduction contributions that an employee may elect to
have made to a flexible spending arrangement for any plan year is $2,500.

TAX NEWS

President Barack Obama signed legislation that retroactively extended more than 50 expired tax provisions for 2014, allowing taxpayers to take advantage of a host of tax incentives during this filing season.

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